Commentaries

Now raising intellectual capital

The VaR cover-up

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By Pablo Triana

Pablo Triana is the author of Lecturing Birds On Flying: Can Mathematical Theories Destroy The Financial Markets? The views expressed are his own

Last month, several men and women assembled in a somber room in Washington to discuss one of the key issues (in my opinion, the key issue) behind the financial crisis that has caused so much misery.

Among those gathered were leading politicians and top financial professionals. A world-renowned bestselling author was there, too. You might think that the media would have devoted attention to such an important event. Surely journalists wouldn’t want to miss the opportunity to report on a roundtable of policymakers and experts that promised to tackle the true factors behind the mayhem, right?

Wrong.
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Automatic debt-to-equity swap?

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That’s what Fed Governor Daniel Tarullo seems to be advocating in his speech, which you can find here.

Here’s the graph, emphasis mine:

We must also adopt new regulatory mechanisms to counteract the systemic and too-big-to-fail problems that became so embedded in our financial system. One possible approach is a special charge–possibly a special capital requirement–that would be calibrated to the systemic importance of a firm. Needless to say, developing a metric for such a requirement is a new, and not altogether straightforward, exercise. Another proposal, which strikes me as having particular promise, is that large financial institutions be required to have specified forms of “contingent capital.” One form of this proposal would have firms regularly issue special debt instruments that would convert to equity during times of financial stress. If well devised, such instruments would not only provide an increased capital buffer at the moment when it is most needed. They would also inject an additional element of market discipline into large financial firms, since the price of those instruments would reflect market perceptions of the stability of the firm.

Volker cuts through it

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Paul Volcker, the former Fed chairman whose nerves of steel broke the back of double-digit inflation 30 years ago, shows that he’s still one of the few in government that wants to call the tough shots.  Too bad he isn’t more influential. If he were, I doubt Wall Street would be talking about getting back to business as usual.

From the WSJ:

Mr. Volcker, who currently is chairman of the White House’s Economic Recovery Advisory Board, suggested banks should be restricted to trading on their client’s behalf instead of making bets with their own money through internal units that often act like hedge funds.

Why banks should welcome “living wills”

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A year after Lehman Brothers collapsed, policymakers are still getting to grips with the key question raised by the Wall Street firm’s fall: how to ensure that the failure of a large bank does not jeopardise the entire financial system.

After much debate, politicians and central bankers are warming to the idea that banks should make preparations for their own failure. This plan — memorably dubbed a “living will” by Mervyn King, governor of the Bank of England — would allow regulators to wind down even large, cross-border institutions without putting public money at risk.

Cleaning up the mess that remains

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At least the Obama administration isn’t saying “Mission Accomplished.”

In marking the anniversary of Lehman Brothers’ demise, the administration understandably focused on how far we’ve come since, and on the various exit strategies in the works.

Obama urging Wall Street to do the right thing

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In his speech, Obama emphasizes that big banks should take it upon themselves to give back to the community after the tax payer has done so much to put them on them on the road to recovery. While I agree with the point in theory, I’m not sure Wall Street is built to think about the moral imperative of creating a better society when it’s primary goal is to make money.

Wall Street, and I use this term broadly, has already demonstrated that when it’s presented with a  choice, it chooses the money. While many bristle at the thought of more regulation, especially when it means it could undermine financial innovation – God forbid – one of the important take aways from the crisis should be there needs to be a counterweight to greed. The industry cannot regulate itself.

Squeeze is on for investment banks

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Peter Thal Larsen.jpgInvestment banks are facing a big squeeze. For an industry that was generating record revenues just months after the collapse of Lehman Brothers, this may seem unlikely. But the revival looks set to be short-lived. Increased regulation and greater competition means the super-charged returns the industry generated for most of the past decade are likely to prove elusive.

Analysts at JPMorgan believe 2009 will prove to be the high point in the investment banks’ relentless upward march. They expect revenues in 2011 to be no higher than in 2006. More significantly, the industry’s return on equity will fall to 10.8 percent, far lower than what they have got used to.

Orange squeezes the UK’s mobile competition

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Merging T-Mobile UK with Orange will bring 3.5 billion pounds of value to shareholders, and “substantial benefits to UK customers.” Goodness, why on earth didn’t they get together years ago? A merger that simultaneously enriches shareholders and customers is rare indeed, and one to be treasured – if this really is one of those seldom-seen beasts.

While the 3.5 billion pound figure is credible, the second claim, from Timotheus Hottges, the finance director of Deutsche Telecom, T-Mobile’s parent, is harder to believe. The immediate reaction from other shares in the sector rather gave the game away, with retailer Carphone Warehouse down on the prospect of fewer suppliers, and Vodafone up on the hope of less competition in Britain’s mobile phone market.

Wall Street’s $4 trillion kitty

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matthewgoldstein.jpgThe Obama administration’s plan for reining in derivatives leaves unchecked one of Wall Street’s dirty little secrets: the ability of a derivatives dealer to redeploy cash collateral that gets posted by one of its trading partners.

On Wall Street, this practice of taking collateral and reusing it is called rehypothecation. In essence, it’s a form of free money for derivatives dealers to use as they please — even to repost it as collateral to finance their parent company’s own borrowings.

Team Obama punts again on derivatives

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The Obama administration formally sent its plan for regulating derivatives to Capitol Hill today. And to no one’s surprise, the key proposal in the 115-bill is a plan to regulate “standard” derivatives on regulated exchanges of clearinghouses.

As I’ve pointed out a number of times, Team Obama has yet to come-up with a workable definition for a standard derivative. The administration seems content to kick the issue down the road.

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